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  • Insurance Deductibles as a Screening Mechanism

Self-Selection in Insurance Contracts

Self-selection is the process by which individuals sort themselves into groups based on their private information, in response to choices offered by an uninformed party. In insurance, when offered a menu of contracts (e.g., high-deductible/low-premium vs. low-deductible/high-premium), high-risk individuals tend to choose the low-deductible plan, while low-risk individuals choose the high-deductible plan. This behavior reveals their hidden risk type to the insurer.

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Economics

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Related

  • Limitations of Deductibles as a Screening Tool

  • Self-Selection in Insurance Contracts

Learn After

  • Predicting Insurance Choices

  • A car insurance company that previously offered a single, standardized policy to all its customers decides to introduce a new strategy. It now offers two distinct plans: Plan X has a very low deductible but a high monthly premium, while Plan Y has a very high deductible but a low monthly premium. From the company's perspective, what is the primary analytical benefit of offering this choice?

  • Consumer Rationale in Insurance Selection

  • Rationale for Insurance Plan Selection

  • An insurance company offers two health plans. Match each customer profile to the insurance plan and rationale that best reflects their likely choice due to self-selection.

  • An insurance company is guaranteed to successfully separate high-risk and low-risk customers into different plans as long as it offers a choice between a high-premium/low-deductible policy and a low-premium/high-deductible policy.

  • When an insurance company offers a menu of policies with different premium-deductible trade-offs, the process of customers choosing plans that align with their private risk assessment is known as ____, which helps the insurer overcome the problem of hidden information.

  • An insurance company faces a market with both high-risk and low-risk individuals but cannot initially distinguish between them. Arrange the following events in the logical order that illustrates the process of self-selection.

  • An auto insurance company offers two distinct plans to a population of drivers with varying, but unobservable, risk levels. Plan A has a high monthly premium and a very low deductible. Plan B has a low monthly premium and a very high deductible. Which statement best analyzes the underlying economic principle that causes drivers to sort themselves by risk when choosing between these two plans?

  • Critique of an Insurance Strategy